Moody’s takes some pressure off Turkey

Moody’s disappointed a lot of folks this week when it failed to raise Turkey’s credit rating to investment grade.

After Fitch upped Turkey on Nov 5 into the coveted top tier, hopes were high that Moody’s would do the same and soon. Being rated investment grade by at least two agencies has a lot of pluses . But all the subsequent investment inflows have side effects and one of them is currency appreciation. Check out these graphs. (click to enlarge)

The currency has been a headache for Turkey’s central bank for a while now. Back in 2010, lira appreciation was the motivation for embarking on an unorthodox monetary policy. This year in nominal terms the lira has gained just over 5 percent against the dollar, as Turkish stocks and bonds, among the best performers in the world in 2012, have lured foreigners.

But other currencies, such as the Polish zloty and Mexican peso, have appreciated more. Turkey’s main problem is the real effective exchange rate (REER) which the central bank is focusing on. In real terms, against the currencies of its trade partners and adjusted for inflation, the lira has risen more than 7 percent to the highest in almost two years . That’s because the country’s inflation rate until recently was almost in double digits.

Caught between inflation and the lira, the central bank must walk a fine line on monetary policy. Murat Toprak, an emerging markets strategist at HSBC, says:

The central bank is in a situation when it has to manage an inflation rate that is above target so they have to make sure the lira doesn’t weaken dramatically. What they want is a slightly weaker currency to gain competitiveness but not a much weaker currency. We are not at 2010, when the policy was really to weaken the currency. Today they are saying what they fear is a further appreciation of the lira on the back of the upgrade.

So an upgrade from Moody’s this week would have piled more pressure on the bank. It got away at yesterday’s policy meeting by cutting only one of its policy rates and threatening more if needed.

According to Tim Ash at Standard Bank:

In a strange way the delay by Moody’s kind of helps the central bank in terms of managing inflows and over-appreciation of the exchange rate.

So will more rate cuts happen in December? A Moody’s upgrade is likely only next year now. Central bank action until then hinges on first, whether portfolio flows keep coming in and second, whether inflation eases and slows the REER appreciation.